FxWirePro: Euro creeps-up on Italian fiscal shift - EUR/JPY OTC indications and FX options recommendation ahead of Eurozone PMIs

It is not exactly as if Italy had suddenly become reasonable on the fiscal policy front. With risk premiums in the area of 305 to 315bp (for 10-year government bonds versus Bunds) the bond market still sees an increased risk in the Italian government’s fiscal policy. However, what is relevant for the FX market is that this risk premium has not widened recently, but is moving sideways in the above range. That means the level constitutes a reasonable compensation for Italy’s fiscal risks – or so it would seem. As the Italian treasury will be able to manage these sorts of yield levels, there is currently no risk of a spiral of higher yields and growing fiscal risks developing. It is not sure whether that is fundamentally justified and in particular whether this properly reflects the political risks emanating from Italy. 

On Friday, the euro recovery was majorly due to a USD effect, but there is a lot to suggest that the EUR weakness is coming to an end unless Rome produces new disturbing signals. 

EURJPY IV skewness: Please be noted that the positively skewed implied volatility (IVs) of 2m tenors are signifying the hedging interests for the bearish risks. The bids for OTM puts of these tenors signal that the underlying spot FX likely to break below 124 levels so that OTM instruments would expire in-the-money. The spot may trend around those strikes as the holders of the options will aggressively hedge the underlying delta. 

Risk reversals: Most importantly, to substantiate the downside risk sentiments as stated above, bearish neutral risk reversal numbers of EURJPY across all tenors are also indicating bearish risks remain intact in the long run. While shrinking IVs that are on lower side, is interpreted as conducive for put option writers.

We have French and German data of manufacturing and service PMI numbers this week. Eurozone manufacturing PMIs are forecasted to be unchanged, while service PMIs are likely to show a minor dip, (manufacturing PMIs: consensus – 52.0, previous – 52.0; service PMIs: consensus – 53.6, previous – 53.7). These are leading indicators of economic health - businesses reactions to the prevailing market circumstances.

Options Trade Tips (EURJPY): Contemplating all the above aspects, we advocate buying 2m EURJPY ATM -0.49 delta puts for aggressive bears on the hedging grounds. If expiry is not near, delta movement wouldn’t be 1 point increase with 1 pip in the underlying spot FX. Which means if the spot FX moves 1 pip, depending on the strike price of the option, the option would also move less than 1. Source: sentrix, saxobank

Currency Strength Index:FxWirePro's hourly EUR spot index is flashing at -46 levels (which is bearish), hourly JPY spot index was at 154 (bullish) while articulating at (09:55 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex